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Europe's June summit agreement looks in danger of coming apart today
07/09/2012 1:33 pm EST
The meeting of European finance ministers that began today and that really gets up to speed tomorrow has turned into a fight over what was actually agreed at the June summit. Some finance ministers and officials at the EuroZone finance ministers meeting today are saying that the June summit changed nothing and that any rescue money to European banks would still be the responsibility of national governments.
In their immediate post-summit statements it seemed like European leaders had agreed that the European rescue fund, the soon to go-into-business European Stability Mechanism, would be able to capitalize troubled banks directly rather than, as in the current system, having to send money to national governments that then send it on to banks. The way things are set up now any money from the rescue fund to a bank counts on the books of the individual national government. That puts the national government deeper in the hole, which hurts the bonds of that government that banks hold, which sends the price of those bonds down, which puts troubled banks further into trouble, which increases the size of any rescue they might need. The negative feedback loop is especially powerful since current European banking regulations encourage banks to buy the bonds of their own national governments by counting them as risk free capital.
But in the run up to today’s meeting of finance ministers senior officials at the Eurogroup, the organization of EuroZone finance ministers that is meeting today before tomorrow’s meeting of all European Union finance ministers, are saying that even if the bailout funds go straight to banks, the host national government would still have to take on the burden of the bailout money. Any bailout or capital infusion into a bank would only be possible if the national government provided a guarantee for the cash. Which, of course, raises the question of how this would show up on the national accounts and whether the accounting treatment would indeed break the link between troubled bank and troubled sovereign debt.
Oh, and Germany and other northern European finance ministers are repeating their insistence that the rescue fund can only undertake direct capital infusions into banks once the EuroZone has set up a new EuroZone wide system of banking supervision. The June summit envisioned that such a new banking regulatory system, with the European Central Bank assuming the role of single bank regulator, could be set up by the end of 2012. But since the summit the true extent of the differences that still need to be bridged before that new regulator can be set up has emerged. Germany, for example, would like to see a system that regulated only the biggest European banks and that left its own troubled regional banks to a national regulator.
Today, at least, the December deadline that was so glibly promised at the June summit seems a pipedream.
And meanwhile, Spanish and Italian bond yields continue to climb into the danger zone and beyond. Today the yield on the Spanish 10-year government bond climbed another 0.09 percentage points to an unsustainable 7.07%. The yield on the Italian 10-year bond rose 0.08 percentage points to 6.11% ahead of the Italian bond auction at the end of the week.
The danger is that with no help on the immediate horizon traders can without fear increase their bets against Spanish and Italian government debt.
And in the realm of outlier events, keep your eye out for a ruling by the Germany Constitutional Curt tomorrow. The court has been asked for a temporary injunction to stop the startup of the European Stability Mechanism. If the court grants the injunction on constitutional grounds, I’d expect a day of very heavy volatility in European financial markets.
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